February 2010 — Issue 48

LLP Cases: Evanston Ins. Co. v. Dillard Dep’t Stores, Inc.,

602 F.3d 610 (5th Cir. 2010)

Dillard Department Stores, Inc. (“Dillard’s”) sued a law firm, Chargois & Ernster, L.L.P., in 2003 for federal and state trademark infringement, cyberpiracy, and various business torts based on the law firm’s use of the Dillard’s name and logo on a website developed by the law firm to solicit clients with claims against Dillard’s. The law firm was registered as a Texas limited liability partnership. Early in 2004, while the litigation with Dillard’s was ongoing, the partners executed a separation agreement providing for dissolution of the partnership, and they did not renew the firm’s LLP registration when it expired in July, 2004. In November, 2004, the court entered a final judgment against “Chargois & Ernster, L.L.P.” Dillard’s was unable to collect the judgment, and Dillard’s filed a complaint against the two partners of the law firm in 2008. Each partner was served, and Dillard’s sought summary judgment declaring that the partners were personally liable on the judgment against the law firm. The district court granted summary judgment, and the partners appealed. The partners argued that they were protected from liability under the provisions of the Texas Revised Partnership Act. The court rejected the partners’ argument that they were protected from liability under the LLP provision of the Texas Revised Partnership Act that provided a partner is not liable for a debt or obligation of the partnership incurred while the partnership is an LLP. The partners argued that the law firm’s debt was incurred when the infringing website was created in 2003, at which time the firm was registered as an LLP. Noting that the terms “debt” and “incurred” are not defined in the statute, the court found, however, that a plain reading of the statute supported the argument of Dillard’s that the debt was incurred when the judgment was entered in 2004, at which time the LLP registration had expired. The court stated that the underlying conduct gave rise to the possibility of a future debt, but that a debt was not incurred at that time because the conduct might have gone undetected, might have been adjudged innocent, or Dillard’s might have opted not to sue. The parties did not rely on another provision of the LLP statute that states a partner is not personally liable for another person’s “errors, omissions, negligence, incompetence, or malfeasance committed while the partnership is a registered limited liability partnership,” but the court considered it significant that liability of a partner is limited for malfeasance “committed” while the partnership is an LLP. The court stated that the legislature’s use of different language created a regime in which partners could be held liable for debts and obligations incurred when the partnership is not a registered LLP but would not bear liability for one another’s “independent malfeasance” committed while it is an LLP. Thus, the court concluded that the partners in this case were not protected from personal liability because the law firm was not registered as an LLP at the time its debt was incurred. After rejecting the partners’ argument that they were protected from liability under the LLP provisions of the Texas Revised Partnership Act, the court addressed the partners’ argument that Dillard’s was required to sue the partners in the suit against the partnership in order to hold them liable for the trademark infringement and tort claims. The partners relied upon a provision of the Texas Revised Partnership Act that states a judgment against a partnership is not itself a judgment against the partners. The court did not find this provision to be helpful to the partners because Dillard’s did not rely on the judgment against the partnership “by itself.” Dillard’s relied upon a judgment obtained against the partners in a separate suit against them to enforce a pre-existing judgment by holding the partners individually liable for the partnership’s debt. The court also distinguished Kao Holdings L.P. v. Young, in which the Texas Supreme Court interpreted the provision of the Texas Revised Partnership Act in issue and held that its purpose was to make clear that a judgment against a partnership is not automatically a judgment against a partner and that a judgment cannot be entered against a partner who has not been served merely because a judgment has been rendered against the partnership. Here, the court pointed out, the partners were defendants in a separate action, which they lost after mounting a vigorous defense, and a judgment was not “automatically” entered against them. Finally, the partners argued that the action against them was barred by the statute of limitations because the claims against them were the same as the claims against the partnership, i.e., claims based on tort and trademark infringement. Dillard’s argued, however, that its action was one for debt, i.e., to enforce the judgment against the partners based on their statutory joint and several liability. The court agreed with Dillard’s, relying on In re Jones, 161 B.R. 180 (Bankr. N.D. Tex. 1993). The court quoted In re Jones for the proposition that a party can either sue partners along with the partnership so that a judgment can be entered against the partners when liability against the partnership is established, or a party can sue the partnership and bring a subsequent suit against the partners on their liability for the partnership’s obligation after liability of the partnership is established. Dillard’s chose the latter course of action, and the court stated that Dillard’s was thus seeking to impose liability on the partners for partnership debt by operation of law. The court concluded that the applicable statute of limitations was the four-year statute of limitations for suit on a debt and that it began to accrue, at the earliest, upon entry of the judgment against the partnership on November 2, 2004. The suit against the partners was brought January 10, 2008, and the action thus was not time-barred.

LLC Cases: Olson v. Halvorsen

986 A.2d 1150 (Del. 2009)

The Delaware Supreme Court affirmed the chancery court’s judgment that the one-year provision of the statute of frauds provision applied to an unsigned LLC agreement and precluded enforcement of an earn-out provision that could not be performed in one year. The court held that the Delaware LLC statute’s recognition of oral and implied agreements does not preclude application of the statute of frauds but instead gives maximum effect to LLC agreements by treating them like other contracts. The court concluded that the statute of frauds and LLC statute can be construed together and that the legislative text and legislative history of the LLC statute gave no indication the legislature intended to render the statute of frauds inapplicable. (The Delaware Legislature subsequently amended the LLC statute to specify that an LLC agreement is not subject to the statute of frauds.)

In re ALH Holding LLC

675 F.Supp.2d 462 (D. Del. 2009)

The issue in this case was whether the members of the “Supervisory Board” of a Delaware LLC breached their fiduciary duties in approving the sale of the LLC’s subsidiaries on a piece-meal basis. After the LLC became financially distressed and the Board was not successful in finding a buyer for the LLC as a whole, the Board approved the piece-meal sale of its three operating divisions. In this consolidated action of two actions brought by the parties against one another, the court discussed the duties owed under Delaware law, the freedom to contract regarding such duties in the operating agreement, the application of default and contractual standards to the facts of the case, and the operation of the statutory indemnification provisions in the absence of any provision in the operating agreement. The court recognized the contractual freedom LLC members have to expand, restrict, and eliminate duties and stated: “In addition to any contractual limitations upon fiduciary duties that the members of an LLC might agree upon, the business judgment rule protects directors from spurious claims against their exercise of discretion in an effort to ‘promote the full and free exercise of the managerial power granted to Delaware directors.’” The court analyzed the claims in light of the operating agreement, which provided that a manager or representative serving on the supervisory board was not liable for damages to the LLC or its members for any act in good faith, but such persons were liable for their own fraud, criminal action, bad faith, or gross negligence. The court characterized the provision as imposing the traditional duty of care but retaining only a subset of the duty of loyalty in its prohibition against bad faith actions. The court discussed the concepts of bad faith and gross negligence under Delaware corporate law and concluded that neither bad faith nor gross negligence had been established in connection with the Board’s decision to sell the operating divisions. The court alternatively examined the record for compliance with the unmodified duty of loyalty, stating that by default the directors of an LLC owe a fiduciary duty of loyalty to the LLC and its members. The court examined arguments that the sale was an interested transaction and that a majority of the board lacked independence because three of the Board’s five members were appointed and employed by the majority member of the LLC. The court commented that the majority member of the LLC owed the fiduciary duty of loyalty to the LLC and its members because of its controlling interest, but the court rejected the arguments that the sale involved self-dealing or interested behavior because the members similarly situated to the majority member received proportionate benefits. The court also concluded that the majority member’s employment of a majority of the Board of the LLC did not itself overcome the presumption of the business judgment rule. Having found no breach of fiduciary duty on the part of the Board, the court turned to their claim for indemnification. The court noted that the Delaware LLC statute permits the members of an LLC to contract to indemnify members and managers and grants the contracting parties broad authority to determine the nature and extent of indemnification, but the operating agreement in this case contained no provision regarding indemnification. The Board members who were sued for breach of fiduciary duty sought a declaration confirming the LLC’s authority to indemnify them, and the court stated that such a declaration would presumably allow the Board members to use their majority position to indemnify themselves. The court refused to sanction an interested transaction of this nature absent a pre-existing provision in the operating agreement. Finally, the court rejected the claim that the breach of fiduciary duty claims were brought in bad faith so as to support an award of attorney’s fees in favor of the prevailing parties. Among the reasons the court cited in support of its conclusion that bad faith had not been demonstrated was the failure of the Board to obtain a fairness opinion. Although the court had earlier acknowledged that a fairness opinion was not required as part of the sale process, the court stated that the claims were not “meritless” in light of the failure to do so, and the court commented that a fairness opinion might well have obviated the need for the litigation altogether.

Pointer v. Castellani

918 N.E.2d 801 (Mass. 2009)

Pointer, a minority member of a Massachusetts LLC who was terminated as its president, sued the other three members and the LLC alleging that the defendants engaged in a freeze-out, breached their fiduciary duty, breached Pointer’s employment agreement and the covenant of good faith and fair dealing, and interfered with an advantageous relationship. The defendants counterclaimed, alleging that Pointer usurped a company opportunity, breached his fiduciary duty, breached his employment contract, and breached the implied covenant of good faith and fair dealing in relation to the operating agreement and employment contract. Pointer had been employed in the granite business operated by the LLC prior to its acquisition by the LLC. When the granite business was acquired by the LLC, Pointer joined with Castellani, Woodberry, and Herbert to form the LLC. Castellani and Woodberry owned 51% of the LLC, Pointer owned 43%, and Herbert owned 6%. Pointer became president of the LLC, and Herbert acted as chief financial officer. Castellani, Pointer, and Herbert were the managers of the LLC. The operating agreement stated that the purpose of the LLC was to operate a quarry business and allowed members to conduct any other business or activity without being accountable. The operating agreement contemplated dealings with members and their affiliates and required that such dealings be at arm’s length and on commercially reasonable terms. Pointer had an employment contract that only allowed his removal without one year’s notice on certain grounds, including dishonest or disloyal behavior, material breach of the operating agreement, or substantial failure to perform his duty. The employment agreement required Pointer to work exclusively for the LLC, but the agreement also stated that Pointer could perform services for another company that he formed with another investor to purchase a residential subdivision that the owner of the granite business insisted on selling when the granite business was sold. Although Pointer did not disclose to the other members of the LLC the extent of his ownership in the company that owned the subdivision and another company that later acquired real estate from the LLC, the trial judge found that all the participants knew that Pointer was involved in other real estate activities that were relevant to the suit. The investor with whom Pointer formed the company to purchase the subdivision at the time the granite business was acquired by the LLC also had an interest in purchasing a piece of property acquired by the LLC in the acquisition of the granite business. Ultimately, Pointer joined with this other investor in acquiring the LLC’s tract of land in order to pursue a real estate development opportunity. This transaction and certain other actions of Pointer were the basis of the defendants’ defense as well as their counterclaims. Pointer’s claims were based on the hiring of a new chief executive officer and the termination of Pointer’s employment. The defendants argued that the termination of Pointer’s employment was justified based on alleged improper business practices of Pointer that had come to light as well as his participation in the transaction involving the sale of the LLC’s real estate, and the defendants further asserted that the real estate transaction constituted improper self-dealing and usurpation of a corporate opportunity by Pointer. The Massachusetts Supreme Court applied Massachusetts case law on closely held corporations in analyzing the claims and determined that the trial judge did not err in finding for Pointer on his freeze-out and wrongful termination claims. The court stated that a breach of fiduciary duty through a freeze-out occurs when the “reasonable expectations” of a shareholder are frustrated. The court acknowledged that the majority shareholders are permitted a measure of discretion in hiring and firing employees and that a court must allow the controlling group an opportunity to demonstrate a “legitimate business purpose” for its actions. The court reviewed the reasons offered by the defendants for Pointer’s termination and concluded that the defendants did not establish a legitimate business purpose. According to the court, the trial court did not err in finding that only one of the allegations of improper business practices involved actual misconduct on Pointer’s part and that termination was not necessary in that regard because all the owners had to do was talk to Pointer about the matter for it to be corrected. With regard to the self-dealing and usurpation of corporate opportunity claims, the court upheld the trial court’s decision in favor of Pointer. The court concluded that provisions of the operating agreement defining a limited purpose of the LLC and permitting members to conduct other businesses and activities supported the trial court’s conclusion that the real estate development activity in which Pointer was involved was not a corporate opportunity of the LLC. The court characterized the defendants’ reliance on a provision of the operating agreement imposing on managers the fiduciary duty of a director of a corporation as misplaced because there would first have to be a corporate opportunity for Pointer to breach a duty. The court pointed out that the record supported the trial judge’s conclusion that the remaining members had no interest in the real estate and that there was sufficient information available to the members regarding the relationship of the LLC’s piece of property to the development opportunity to allow them to take action if they had been interested in doing so. The court acknowledged that the sale of the LLC’s property was unquestionably a corporate opportunity once the LLC decided to sell, but the court rejected the defendants’ challenge to the trial court’s finding that Pointer engaged in unfair self dealing in the transaction. Although Pointer did not reveal that he owned 50% of the entity purchasing the property from the LLC, he did not participate in the vote on the sale and the transaction was negotiated between Castellani and Pointer’s fellow investor. The record showed that the other members knew that Pointer owned part of the entity acquiring the property and that Pointer and his fellow investor were assembling parcels of land for development. Although Pointer did not disclose that his fellow investor was pursuing the parcel at a discounted price as compared to the price specified in an option held by the investor, the record showed that the members were aware they could hold out for a higher price in the future but preferred to sell rather than risk the deal falling apart. There was also expert testimony that the price was a commercially reasonable price. The court thus held that the trial judge did not err in concluding that the transaction was fundamentally fair. The court upheld the trial court’s finding that Castellani, Woodberry, Herbert, and the new CEO were liable for interference with Pointer’s employment contract with the LLC because they terminated Pointer for cause that was contrived. The court found no error in the trial court’s conclusion that Pointer was entitled to indemnification under the indemnification provisions of the operating agreement, which required indemnification of managers and members unless their action or inaction was the result of active and deliberate dishonesty. The defendants argued that the trial judge’s findings indicated that Pointer was, at the very least, dishonest, but the court cited statements by the trial court that its decision did not include any findings that Pointer committed actions in bad faith or with deliberate dishonesty. Finally, the court discussed the remedy for a freeze-out and remanded for further proceedings because the court concluded that the trial judge’s order for a forced sale of the LLC violated the court’s holding in Brodie v. Jordan, in which the court held that a forced buy-out of a shareholder was improper without some authorization from the shareholders. The court stated that Pointer was entitled to damages or other equitable relief that would put Pointer in the position he would have been in had the freeze-out not occurred and compensate him for the denial of his reasonable expectations.

OLP, L.L.C. v. Burningham

225 P.3d 177 (Utah 2009)

The Utah Supreme Court concluded that the Utah LLC statute does not displace common law claims or remedies available to an LLC member and affirmed a judgment in favor of an LLC member against his fellow member for damages based on repudiation of their agreement to equally own and operate an LLC. Wilson and Burningham formed an LLC to which they contributed equal amounts of cash, and they orally agreed to share equal control and ownership. After disputes between the members developed and the parties were unable to agree whether amounts provided by a company owned by Burningham were loans or capital contributions, Wilson sued Burningham seeking legal and equitable remedies for breach of fiduciary duty, repudiation, breach of contract, and other contract-related claims. Burningham asserted a counterclaim for judicial dissolution and argued that the damages should be determined in an accounting and should be limited to the balance of each member’s capital account as provided by the default ownership provisions of the LLC statute. The trial court allowed Wilson’s claims to be tried to a jury, and the jury awarded damages based on a finding that Burningham repudiated the LLC agreement. Burningham argued that the trial court erred by not applying the LLC statute to the computation of damages, but the supreme court held that the LLC statute did not supersede common law tort and contract claims and that members of an LLC can choose either to pursue common law claims or to dissolve the LLC under the statute and receive their interest in the LLC after an accounting and winding up. The court rejected the argument that the “exclusivity rule” should apply to disputes among members in the LLC context as it has historically applied to the remedy of an accounting in the partnership context. The court held that a member may sue another member for repudiating the LLC and that such an action is a separate claim for damages that does not require formal dissolution and winding up. The court explained that common law repudiation is applicable in an LLC contract dispute when one member refuses to perform the agreement and thereby abandons the purpose of the contract. A party need not disavow the LLC’s existence to repudiate the contract. Based on the jury’s finding that Burningham repudiated the contract to form and operate the LLC as equal members, the court concluded that Burningham abandoned his ability to seek resolution of the dispute according to the LLC’s governing documents or the default provisions of the LLC statute. With a finding of repudiation, the court said there was no LLC and no requirement for dissolution and winding up. There was also no need for an accounting because the jury’s factual determinations in the determining the legal issues were binding.

Leedreau, LLC v. Commissioner of Internal Revenue

T.C. Summ. Op. 2009-05, 2009 WL 4824207 (U.S. Tax. Ct. Dec. 15, 2009)

(liability of single member of disregarded LLC for employment taxes prior to 2009).

Lynn v. Romar Marina Club, LLC,

Civil Action No. 07-0173-KD-C, 2009 WL 4667387 (S.D. Ala. Dec. 1, 2009)

(lack of power and authority of non-manager member under operating agreement and common law agency principles).

Federal Trade Commission v. Bronson Partners

LLC, 674 F.Supp.2d 373 (D. Conn. 2009)

(liability of Texas LLC for false advertising claims against member based on alter ego).

Big Bucks Preserve, LLC v. Columbia Gulf Transmission Co.

No. Civ. A. 08-2021, 2009 WL 5173929 (W.D. La. Dec. 30, 2009)

(inability of LLC to recover for emotional distress, mental or emotional harm, or loss of enjoyment of hunting season; inability of LLC to pierce its own veil).

Bluewater Logistics, LLC v. Williford

, __ So.3d __, 2009 WL 4801017 (Miss. App. 2009)

(termination of member’s employment by LLC as not constituting termination of membership; unavailability of appraisal and payment right under statute or agreement).

Bootheel Ethanol Investments, L.L.C. v. Semo Ethanol Cooperative

No. 1:08CV59SNLJ, 2009 WL 4891960 (E.D. Mo. Dec. 10, 2009)

(statutory preclusion of suit for breach of operating agreement provision prohibiting withdrawal of capital contribution; interpretation of various provisions of operating agreement; apparent unavailability of fraudulent transfer action against individuals facilitating fraudulent transfer).

Cottone v. Selective Surfaces, Inc.

892 N.Y.S.2d 466 (App. Div. 2d Div. 2009)

(potential constructive trust and accounting remedies for breach of fiduciary duty; fact issues regarding variance between oral and unsigned written agreement; unavailability of fraudulent conveyance claim to derivative plaintiff for conveyance of LLC’s own assets; one-year provision of statute of frauds as not barring agreement by which plaintiff allegedly acquired LLC interest; application of six-year statute of limitations rather than three-year statute of limitations to fiduciary duty claims based on nature of relief sought).

A.B. Medical Services, PLLC v. Travelers Indemnity Company

895 N.Y.S.2d 759 (N.Y. Sup. 2009)

(ability of disqualified professional to conduct winding up of professional LLC).

Van Dyke v. CMI Terex Corporation

689 S.E.2d 459 (N.C. App. 2009)

(fact issue as to application of exclusivity provision of workers’ compensation statute to shareholder of parent of corporate member of LLC that employed worker involved in fatal accident)

In re Saxby’s Coffee Worldwide, LLC (Saxby’s Coffee Worldwide, LLC v. Larson)

Bankruptcy No. 09-15898 ELF, Adversary No. 09-0340, 2009 WL 4730238 (Bankr. E.D. Pa. Dec. 4, 2009)

(issuance of stay to protect non-debtor members of debtor LLC based on threat to reorganization plan presented if members had to defend themselves from pending lawsuits).